Nov 05 2008
Adjustable Rate Mortgages (ARM’s) – A Tale of Two Indices.
Much has been made lately in the press about the impending peril homeowners may be facing when their 5/1 or 7/1 Adjustable Rate Mortgages (ARMs) complete their fixed-period and covert to an ARM. After all, when the first wave of mortgages indexed sharply upwards last year, it marked the beginning of the sub-prime meltdown that we’re still sorting through today.
But just because you have an ARM that’s due to index soon, does it mean you should be losing sleep at night waiting for your adjustment letter to arrive in the mail? Not necessarily. It all depends on which index your ARM is based on. If you recall, the fully indexed interest rate is calculated by a simple equation:
Fully Indexed Rate = Margin + Current Index
Since the margin is a fixed figure that is set by the lender, the “variability” of an ARM will follow the behavior of the index. While there are numerous indices that are used in ARM’s the two most common that are used are the London Inter Bank Lending Rate (LIBOR) or the Constant Maturity Treasury (CMT.) Here’s a great site that keeps track of all of the most common index rates:
These two indices have behaved VERY differently over the past 12 months. LIBOR rates have risen significantly due to the tight money market, while CMT rates as yields have dropped. Consequently, by understanding which index your ARM is based on, you can better anticipate what your loan is going to do when judgment day comes.
How do you know which index your loan is based on? It is specified on your original loan documentation, or you can call your lender and find out. Either way, knowing what your rate is going to do may buy you some much needed peace of mind.
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